The opportunities and risks China faces as it begins its transition from middle income status to a rich nation
I spent the whole of last week in China literally flying from one
city to another – sometimes covering two cities per day. The speed of
change in China is mind boggling. I had not visited Beijing since 2008.
In just six years, I could not recognise it. Even cities that I had
visited in 2011 have expanded so rapidly I could not recognise them
either. Skyscrapers grow like mushrooms even in rural areas where small
towns are building high raised apartments to accommodate the mass of
people leaving farms.
In 1984, Beijing was a city ruled by bicycles. From the video
documentaries of that age that I have, you can hardly see cars on the
streets. Today, China has overtaken the United States as the largest car
market in the world. During rush-hour, it can take someone four hours
to drive the 40km from the airport to Tiananmen Square in spite of the
impressive investments in rails, highways and flyovers. Even in the
small cities and municipal towns I visited, like Wei Hai and Qingdao,
China’s success is evident.
China’s nominal GDP per capita in 1978 was $150 while that of the USA
was $10,000 – so the average American was 66 times richer than the
average Chinese. Today China has leapfrogged the USA; its nominal per
capita income is $6,800 while that of the US is $53,000 – meaning an
average American is now only 7.8 times richer than an average Chinese.
Compare this to Uganda whose nominal GDP per capita in 1978 was $ 200.
An average Ugandan was 50 times poorer than an average American.
However, today, Uganda’s nominal per capita income is 600. Therefore, an
average Ugandan is poorer than an average American by 88 times. Thus,
while China has been converging on America, Uganda has been diverging.
China is now navigating the transition from a middle income (a per
capital income of $5,000 to $10,000) to a rich country status. With GDP
growth remaining at an impressing 8% or more per year combined with
negative populations growth (even with easing of the
one-child-per-family policy, China could double its per capita income
every five years. If China can sustain its current rate of growth, it
will have a nominal per capita income of $17,000 ($30,000 in PPP) in
However, only a few countries have transited from middle income to
rich country status smoothly and successfully – South Korea, Taiwan,
Japan, Western Europe, North America, Australia and some small Island
nations. It is always difficult to break out of middle income status
because the industries that drove growth in the early period start to
become globally uncompetitive due to raising wages. The temptation of
many governments is to try and protect them, rather than let them die.
This is already happening in China as I wrote in this column (see
“Who will succeed China”, The Independent July 4-11). Labour intensive
manufacturing has already begun moving from China to low wage countries.
This demands that China now moves from low wage manufactures to
knowledge-intensive industries where the critical resource is highly
skilled labour i.e. human capital. The transition becomes difficult
because politicians are always tempted to seek to save industries that
employ masses of people – even when they have become globally
Thus, governments may use subsidies, trade barriers like high tariffs
and quotas, foreign exchange manipulation, etc. to protect
uncompetitive industries from the cold winds of international
competition. This is possible because such industries have powerful
domestic interests to promote their cause politically – rich business
persons who own them and labour unions whose members have jobs in them.
Yet in such cases, the best solution would be to protect people (who
lose jobs) not the companies. People can be protected through
unemployment income support, free or affordable healthcare, and
education for them and their child.
The challenge China faces today therefore is whether its leaders will
resist the temptation to protect companies (many of which are owned by
government or by persons allied to the Communist Party) or protect
people. It is difficult to tell because China seems to be doing
everything at the same time – moving towards knowledge intensive sectors
(witness the amount of public and private investment into research and
development). But equally China is trying to protect uncompetitive
industries through different forms of government subsidies, cheap loans,
and foreign aid to poor countries tied to purchase of Chinese products.
The other source of vulnerability for China is the growing debt
levels in the country. Bank credit grew from $10 trillion in 2008 to $24
trillion in 2013 – an unprecedented development in history. Now compare
this with the US where total credit is $14 trillion accumulated over
100 years. China has done it in 5 years. China’s debt is double its GDP.
Debt has grown rapidly because China’s investment has been driven by
debt, not equity. Local governments promote debt driven development
projects of limited economic value and little rate of return because
local politicians profit from corruption and partly because they want to
Also, as new skyscrapers pierce the Chinese skyline almost every
month, the property market is grossly overvalued. Property prices go up
by 20% per year. It will not take long for this to reach economically
unsustainable levels. If property prices collapse, banks will be exposed
to collapse as well. And many Chinese who have invested in housing as
their social security (pension) will come to grief. Equally worrying is
that many state companies are over leveraged. As already mentioned, they
have been expanding on debt. China, like America, is addicted to debt –
There is a lot of corruption in china: In local governments, in state
owned companies – everywhere. China may need to slow down growth
because sustaining high growth on debt is a big risk. Secondly, average
household savings in China are 30% of income. So you have overproduction
and under consumption. May be China needs more private sector ownership
and market principles in this state-led economy.
But reform will be difficult because there are now entrenched
interests profiting from the status quo to accept change. It is
therefore more difficult for China to carry out economic reform without
political reform. To change the current economic system requires
changing the power structure – now, that is political. Will China do it?